When the Bubble Bursts

Friday, October 29, 2004

Soaring shipping stocks may have attracted a raft of new investors including private equity funds and hedge funds, particularly in the U.S., but buyers should beware that shipping has always been and will remain a cyclical business, financier Paul Slater told the Mare Forum meeting in Amsterdam.

“The economics of the shipping industry can appear simple to the outsider but the recent increase in shipping stock values can obscure the risks of the business,” he said.

Pointing out that the wet and dry fleets will expand by 25-40% between now and the end of 2007 while the capacity of the container fleet is due to grow by almost 50%, Slater has a clear warning for newcomers to shipping stocks who believe their stock will continue to rise in value. This level of fleet expansion is only sustainable, he declares, if China and India continue to show double-digit annual growth while the economies of the U.S. and Europe expand by 4-5% for the balance of the decade.

“After all, these hugely populated Asian countries need strong western economies to sustain their growth,” he said.
But these criteria for sustainable growth in shipping are improbable, Slater believes. “The U.S. economy is unlikely to show more than 2.5% annual growth over the next five years, whoever wins the election,” he says, while “the old European economies will be lucky to achieve half that level, particularly if the oil price stays above $35 a barrel.” Meanwhile China is already having problems assimilating the domestic effects of its economic growth since 2001 and “will have to keep the brakes on for the rest of the decade” while India’s rapidly rising oil consumption is likely to continue to grow, but at a slower pace to keep in step with its refining and distribution capabilities.

“The combinations of these economic adjustments will have a great impact on the fortunes of the shipping industry and therefore the market values of public shipping companies,” Slater said. He will draw a comparison between investing in a service industry not subject to rapid changes in technology and crossing a busy road. “Shipping, because of the different factors that affect its economic health, is a two-way street which requires investors to look in both directions when assessing the timing of investment and disinvestments.”

Meanwhile, Slater points out that the combined market value of public shipping companies represents less than 25% of the asset value of the entire industry. And while “the capital requirements of the present orderbook are a staggering $50 billion a year for the next three years,” most shipping companies do not report on their activities, particularly the rates at which they fix their ships.

“There is little or no reporting of period time charter rates, even from public companies, as secrecy has always been the vital tool of competition, particularly in a globally competitive industry.”

Some investors, Slater believes, have been tempted into shipping stocks in the belief that the cash surpluses generated by today’s booming rates will become the norm in the future. “While today’s tanker rates are producing more than $50,000 cash surpluses per ship, one must not ignore the fact that the same ship could well have been losing $15,000 a day less than two years ago”.